Technological disruption and financial markets

Disruption is displacing an existing market, industry or technology to create something new in a more efficient and value-generating way. It is both destructive and creative and very few companies are immune.

Company leaders have an important role to play. Take Kodak, for example; in the 2000’s, it was a company with robust financial information: revenues of $14 billion and a net profit of $1.4 billion. Its main line of business was the sale of rolls of film, each roll of film allowing for the printing of approximately 24 images. However, in 2012, just 12 years later, the company filed for bankruptcy due to increased use of the digital camera. Ironically, the digital camera was invented and patented by Kodak 35 years earlier, but its leaders, at the time, decided to keep their old DNA and not transform it, this decision cost them the company.

When does technological disruption occur?

Tony Seba, a recognized leader and expert in disruptive technologies, author of the book “Clean Disruption of Energy and Transportation” states that technological disruption occurs when “convergence” occurs.

We all know Steve Jobs is a great visionary, but history has forgotten to give credit to the role technology played in the creation of the Iphone. Have you ever wondered why the Iphone came out in 2007?

If the Iphone became a reality in 2007, it’s because each of the technologies needed to make it achieved a feasible production cost that made it possible to combine them and create the first Smartphone. This process is the “convergence” defined by Tony Seba. What were these technologies? The transmission of a bit per dollar, the digital image (dollar per pixel) and the lithium battery (cost of kilowatt per hour per dollar).

Are we living a technological disruption?

One thing is clear, the world is nothing like the world of 10 years ago. Technological disruption has reduced the average life span of S&P 500 companies substantially. In 1964 it was 33 years, in 2016 it was reduced to 24 years and according to a study by Innosight, by 2027 the average life will be 12 years (See Figure I).

Figure 1: Life Expectancy of a Company in the S&P 500


Source: Innosight analysis.

The companies with more value today, are companies that have changed the rules of the game. The dominance of digital platforms has transformed the business model of many industries such as banking, health, transportation, tourism, telecommunications and real estate to name a few.

Digital platforms are powerful, as they provide possibilities of expansion to new growing markets no matter where in the world they are located at speeds never seen before.

By the end of 2019, five companies operating with digital platform technology represent a market value of about $4.9 trillion dollars. These companies are: Microsoft, Apple, Amazon, Google and Facebook (See Table I). Only these five companies represent 39% of the Nasdaq index, which at the end of 2019 obtained a YTD of 35.2%.

Table 1: Top 12 companies over time

Tabla 1: Top 12 de las compañías a través del tiempo
Source: Bloomberg

How do company leaders deal with this reality?

Company leaders and Wall Street agree on the following: A company’s viability year after year depends on its ability to innovate.
According to a survey conducted in 2017 by Innosight, leaders were aware of the importance of technological disruption and innovation. 80% said that their companies need to transform, ie renew their DNA.

Under what degree they recognize the need for transformation, defined as: “change the core operations or business model”.

However, the expectation of reality is distant. According to a Harvard Business Review article “Managing Your Innovation Portfolio,” it shows us that companies’ efforts to innovate are somewhat ill-focused.

Every company has three types of innovative activities:

Core Activities: changes in existing products
Adjacent Activities: allow the company to take advantage of its existing capabilities, but for new uses.
Transformational Activities: create new offerings or change an entire business model for new markets or consumers.

Instead of focusing on transformational and adjacent activities, which would generate a greater return on investment, leaders focus on initiatives related to “core” activities, they concentrate on maintaining their old DNA, because they are doing well. However, focusing on “core” innovations divides the cake into smaller pieces, since it only segments the market more and more and does not make it grow.

Figure 1: Innovation Activities vs. Returns

Source: “Managing Your Innovation Portfolio. Nadji, B.

Technological disruption and financial markets

As investors it is important that disruptive companies with a culture of “transformation” are part of our portfolio. According to Tony Seba, the 2020s will be the most disruptive, so at K&B, through an exhaustive analysis we identify the four sectors that will have the greatest economic impact for the 2020s: Internet of Things, Cloud Computing, Artificial Intelligence and Fintech (See graph 1), and based on this analysis we have managed our home fund, which at the end of 2019 obtained a yield of + 28.8% YTD.

Technology has completely changed the way industries operate their businesses, and technology companies are the ones that have grown the most because they continue to innovate. Microsoft, Apple, Amazon, Google, and Facebook have had 10-year compound annual growth of 21.3%. By way of comparison, the S&P 500 index, for this same period had a compound annual growth of: 11.2%.

 

Lisamarie De Rinjonneau
Portfolio Analyst

To learn more, contact us at:
info@kb-familyoffice.com

 

July, 2019

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